1. Field of the Invention
The present invention generally relates to strategic decision making, and in particular to the development of frameworks for modeling relationships between the core capabilities of a firm.
2. Background Description
A survey of business strategy research reveals a rich body of literature that describes various kinds of modeling and analyses that have been done to aid strategic decision making. These range from various micro economic models, to analyses of structural forces within an organization and an industry, from strategic clustering and categorization to identification of rare and valuable resources and core competencies, from theories of organizational learning to principles for knowledge management. Each of these analyses has proven to be valuable in gaining some particular kind of insight in developing strategies. However, there is no integrating framework that facilitates an appreciation of how they complement or contrast with one another towards the common objective of aiding strategic decisions.
Research discussions on business strategy may be broadly classified into three categories. Those that model the firm as a "black box" operating in an environment of opportunities and threats, those that model the internal capabilities of the firm but ignore the details of the changing environment, and those that start from one of the first two categories and incorporate parts of the other.
The first category of strategy research is typified by Porter's [Michael Porter, Competitive Strategy, The Free Press, 1980] analysis of the external forces that affect the success of a firm. Strategy follows from this analysis by identifying actions that would alter the strengths of these forces in favor of the firm: firms should perform actions that reduce the bargaining power of buyers and suppliers and reduce the threat from new entrants and substitutes. This prescription does not go far enough to take into account the kinds of activities the firm is good or bad at doing. In other words, while the external threats and opportunities are considered in coming up with a strategy, the internal strengths and weaknesses of the firm are not. Porter's subsequent research on value chain analysis [Michael Porter, "What is Strategy?", Harvard Business Review, 32(1), 1996, pp. 10-20] addresses the importance of the primary and support activities performed by the firm. The differences in the strengths and weaknesses of these activities between competitors is used to explain the difference in performance of firms within an industry segment. These activities (and their relative strengths and weaknesses) are viewed solely as the target of strategy implementation and not as a source of strategy definition. The relationships between the activities along the value chain and the external opportunities and threats are not directly established.
The strategic alternatives offered by Porter's approach are cost leadership, product differentiation, or niche focus. The emphasis is not on the tailoring of an individual firm's strategy, but on being a member of one of these broad classifications and not being "stuck in the middle." Miles and Snow [Raymond E. Miles and Charles C. Snow, Fit, Failure and the Hall of Fame, The Free Press, 1994] also suggest that organizations fall into one of three general strategic types: They classify organizations as Defenders, Prospectors, or Analyzers. Each of these strategic categories are associated with the appropriate organizational structure, processes, and technology usage that have been observed to be consistent. This knowledge is used to suggest what a firm must do to be aligned with the strategic category it belongs in. In order to perform this analysis, the details of a firm and its environment are defocused and generalized to fit one of the broad strategic categories. It is in this abstract, general level that the firm is analyzed and the misalignment of its structure and processes is identified. These findings have to be made actionable by focusing them back to the detailed, firm-specific level. The difficulty of the last step lies in the fact that there can be no prescribed methodology by which it could be done. The detailed understanding of the firm, and especially those aspects that make it differ from the typical member of the strategic category are not utilized while performing the general analysis and become hard to fold back into the recommendation phase.
The second category of business research consists of the work done on the resource-based view of the firm [Jay Barney, "Firm Resources and Sustained Competitive Advantage", Journal of Management, 17(1), 1991, pp. 99-120; Ingemar Dierckx and Karel Cool, "Asset Stock Accumulation and Sustainability of Competitive Advantage", Management Science, 35(12), December 1989, pp. 1504-1514; Margaret A. Peteraf, "The Cornerstones of Competitive Advantage: A Resource-Based View", Strategic Management Journal, 14(3), 1993, pp.179-191] and core competencies [Prahalad and Hamel, 1990; Gary Hamel and C. K. Prahalad, Competingfor the Future, Harvard Business School Press, 1994]. They differentiate themselves from the first category by postulating that the central source of competitive advantage is driven by the resources and capabilities within the firm. To be strategically significant and sustainable, these resources and capabilities must be valuable, scarce, and non-tradable (difficult to imitate or substitute). Strategy, in this view, is the identification of and investment in these resources or capabilities. This framework leaves two key concepts implicit: The relationships between resources and the environment and the interrelationships between the resources.
The first relationship is the reason behind the value of a resource. The resource-based view states that the resources should be valuable, but does not explicitly model the conditions under which this is the case. The rapid environmental changes that are being brought about by globalization, deregulation, and technology make it unreasonable to assume that any resource will continue to remain valuable, independent of the scenario in which a firm finds itself operating. This makes it important to condition the value of a resource on the scenario. If this is only implicitly done at the time of the initial assessment of its resources, a firm may find itself investing in the wrong resources as the environment inevitably shifts into a new scenario. The explicit association of resources to scenarios allows the formulation of a strategic plan that dynamically controls investment in resources as new scenarios are forecast and visited.
The second form of relationship acknowledges the fact that resources and capabilities in a firm do not operate in isolation. They enable and improve each other as well as disable or detract from each other. These relations are important to capture because they are, when positive or enabling, often the key toward making a capability rare and hard to imitate. Alternatively, when these relationships are negative or disabling, they explain why some firms cannot capture the full potential value of a resource. Finally, in the absence of these relationships, one runs the risk of looking at a resource in isolation and discounting its value (perhaps because it is tradable) by ignoring the fact that it enables other "valuable" resources. The key breakthrough in core competencies is in identifying these core resources on which the entire firm depends, but this too does not model the explicit relationships in its framework.
The deficiencies identified above are being addressed by research approaches that either start from the internal view of strategy and move to the external side or take the reverse path. As an example of the former, Black and Boal [Janice A. Black and Kimberly B. Boal, "Strategic resources: Traits, configurations and paths to sustainable competitive advantage", Strategic Management Journal, 15(x), 1994, pp. 131-148] describe a research approach that starts from the resource-based view of the firm and incorporates relationships between resources. Here, they do consider causality and the enhancing and suppressing nature of the relationships. This allows them to build decision trees to decide when even a tradable resource may lead to sustainable competitive advantage. However, they do not consider the relationships of resources to external opportunities and threats in determining strategic competitive advantage. The decision trees constructed to judge whether a resource will lead to sustainable competitive advantage are inward looking and do not seem to consider the relevance of the resource in the current external environment or the rents it can obtain. If so, there is nothing preventing someone from using these decision trees to conclude that the resource factors that have been proven to lead to sustainable competitive advantage in the past will continue to do so now or in the future. Finally, like activity webs, all the relationships are strictly Boolean and consequently, so are the decision trees. This prevents an accurate evaluation of a resource that has a strong enhancing relationship with another strategically important resource as well as a weak suppressing relationship with yet another resource, leading to the incorrect conclusion about whether the resource supports sustainability.
Porter [Michael Porter, "What is Strategy?", Harvard Business Review, 32(1), 1996, pp. 10-20] has proposed activity webs to capture at an abstract level, the activities that a firm performs and how they are linked to other activities and the strategic positions the firm wishes to achieve. The nodes of the web represent the strategic positions and the activities that enable them. The connections between the nodes represent the reinforcement between the activities and positions. Porter views strategy as this interconnected web of activities and credits sustainability to the composite of interconnections and activities instead of the individual activities. These webs allow the evaluation of a firm in terms of the consistency and reinforcing effects of its activities. This approach of explicating what is usually a tacit understanding of the relationships between a firm's activities and linking them to the firm's strategic positioning is a step in the right direction, but we feel does not go far enough. It does not distinguish between positions that provide value to the customer from positions that provide value to the firm. This could lead to the design of an activity web that provides consistency and reinforcements to positions that do not provide any value to the market, resulting in a poor strategy that may be hard to abandon for the very same reasons that make a good strategy hard to imitate. Consistency and reinforcements between these two classes of positions should be the object of design. Very often, activities designed to enable strategic positions that provide value to the customer hinder activities and positions that are of value to the firm. Activity webs do not represent these negative relationships, which should be as important as the positive ones. Porter describes firms, such as Southwest Airlines and IKEA, that have made strategic choices of excluding some positions that provide value to the customer. For example, Southwest does not provide pre-assigned seating or baggage transfers to other airlines, IKEA asks the customer to do the delivery and the assembly. These choices can be made only after observing the existence of the conflicting relationships and determining that the value lost from not providing a certain feature to the customer can be more than made up by the value gained from the resulting improvement in another strategic position. In order to fully capture these insights in the representation of a firm's strategy, the following clarifications should be made to the representation provided by Porter:
1. Who is the stakeholder that derives the direct value from a strategic position? Is it a customer, a supplier, or a shareholder? PA0 2. What is the value of a strategic position? Is it due to revenue, marketshare, or mindshare? PA0 3. What is the definition of an "activity"? How detailed should it be? PA0 4. What is the nature of the relationship between two nodes? It may not be enough to say that a relationship exists. Which node is the cause and which is the effect? PA0 5. What is the strength of a relationship? Is it positive (enabling) or negative (suppressing)? Is it possible to provide a quantitative value to represent the strength? Is it probabilistic?
The drawbacks of this framework are in the details. This prevents the use of automation through computational techniques in analyzing the network. As a result, while the activity web is beneficial in exposing the tacit relationships between a firm's various activities, the analysis that can be done once the web is modeled remains implicit. Nevertheless, activity webs represent the merger of the external and internal strategic analyses and therefore a novel and important step in business strategy research.
There have been recent efforts [Strategic Management Journal, Vol 18, Summer Special Issue, 1997] to focus attention away from the debate over whether firm capabilities or market competition have a bigger influence on the success of a firm. Instead, researchers are now trying to understand the way in which capabilities and competition mutually influence each other. However, the effort seems to be in the area of inferring the impact competition has on capabilities and the impact capabilities have on competition. McGahan and Porter [1997] builds upon the work of Rumelt [1991] and Schmalensee [1985] in attempting to explain the statistical variance in firm performance on variances in industry, corporation, and firm (therefore indirectly, on capabilities). Here, the debate is no longer on whether one factor is insignificant compared to the other, but only on the relative importance of the factors. Not surprisingly, the relative performance depends on the industrial sector. Manufacturing industries appear to derive more of their performance variance from variance in firm capabilities, while service industries are more dependent on industry variances. While the usefulness of these studies towards the advancement of strategy research is not in question, it remains unclear how a strategist is supposed to use these results. Should the strategist for a firm in the manufacturing sector start to place strategic emphasis on firm capabilities and not on the competition? Clearly, no one is suggesting such a bipolar view any longer. In that case, the debate over the degree of relative influence by the factors is largely academic, while practitioners continue to wrestle over how to best formulate strategy by placing equal emphasis and rigor on the internal dynamics of the firm and the external interactions with the market. Research on this issue remains lacking. The importance of this void becomes more so now, because the existing strategy formulation frameworks come from researchers that previously belonged to one of the two schools of thought, and therefore are weak in modeling either the market or the firm.
Current research emphasis is on explaining the reciprocity of competition and capability. Economists, ecologists, and many strategists have long established the impact of competition on shaping capabilities. Competition forces price down to the marginal cost, forcing firms to either adapt their capabilities or exit the market. Ecologists place a greater importance on the exit of firms that do not fit the environment as the cause for shaping capabilities, while strategists take the view of conscious organizational change as the cause. This debate and the underlying observation of competition shaping capabilities do not come directly to the aid of those trying to formulate strategy for a firm (except for the futility of their effort if the ecologists are right). The conclusions are too general to be of prescriptive use. Instead, research is required to convert the insight that competition shapes capabilities into a methodology that allows the practitioner to identify the environmental factors that affect the usefulness of a specific capability.
The other aspect of reciprocity is that firm capabilities affect the competition. Studies on this topic use large data samples to identify the internal factors that influence firm performance. These studies statistically confirm fairly intuitive relationships such as, new technological capabilities result in increased market share in the presence of specialized complementary assets, or, collaborative relationships between firms from different industries place more importance on skill sharing. These ideas are not new to strategy practitioners, and the studies confirming them have more academic value than practical and prescriptive significance. Research on the development of frameworks that allow practitioners to explicitly model how and to what extent, capabilities affect each other and external environment is needed to complement the statistical confirmation that such interactions do exist. The objective of such frameworks should be to move beyond generalizations of environments and firm capabilities and towards modeling the specific details of the particular environment and firm capabilities that practitioners find themselves in when they attempt to develop strategies.
A brief scan of the literature on thinking, learning, and decision processes shows that much of our current theory on how people think is based on our ability to form associations among concepts or objects in our environment based on categories. People are tremendously adept classifiers. We quite easily form groupings of the objects in our world according to our past experience. We can span a spectrum of abstract through specialized classes of objects and form these groupings based on associations of the attributes that appear in common among objects. Of all the associations that we might form, we seem to prefer those that aid in making deductive or inductive inferences about classes of objects. (For a very readable overview of this subject, see Thinking: An Invitation to Cognitive Science edited by Smith and Osherson, MIT Press, 1995, especially Chapter 1 "Concepts and Categorization.")
We build our work on the existing research in cognitive science, particularly cognitive mapping, the representation of an interrelated set of concepts in a graph. This basis allows us to develop the basic conceptual building blocks of strategy and to represent the interrelationships among them. In the activity webs described in Porter's most recent article, we see the rudiments of a specialized kind of cognitive map. Activity webs describe a related set of concepts about a particular business. The activities in Porter's webs are conceptually very similar to core capabilities [Gary Hamel and C. K. Prahalad, Competingfor the Future, Harvard Business School Press, 1994], the Resource Based View [Bergerfelt [1982], Miller and Shamsie [1995], Black and Boal [Janice A. Black and Kimberly B. Boal, "Strategic resources: Traits, configurations and paths to sustainable competitive advantage", Strategic Management Journal, 15(x), 1994, pp. 131-148], and many others]. His examples are Southwest Airlines, Ikea, etc. Arranging capabilities in a map showing their interrelationships as Porter has done we believe is novel in the management literature. However, his activity webs miss many features that commonly appear in more formal cognitive mapping. It is these features that give cognitive mapping more analytic power. In particular:
There is no definition of what should comprise a node. PA1 There is no epistemology for different kinds of semantically distinct nodes. PA1 There is no definition for the different kinds of relationships that the webs illustrate. PA1 The relationship lines do not indicate causality. PA1 a. evaluation of the degree of alignment of capabilities and strategic positions, PA1 b. identification of core capabilities, and the degree of dependence of a capability on the capabilities of suppliers and partners. PA1 c. identification of opportunities for new resources and capabilities to reinforce existing ones, PA1 d. estimation of the strategic value of capabilities and resources, and PA1 e. estimation of the implementation and maintenance costs of desired strategic positions. PA1 What capabilities are needed to support my current/desired strategic position? PA1 What resources support/enable these capabilities? PA1 What are the business returns from investments in these resources? PA1 What can be done to increase the returns from investments in these resources?
The lines showing relationships illustrate only that a relationship exists:
Without more detail in the definitions of what concepts are illustrated by the nodes and connecting lines on activity webs, their potential communicative power is unrealized and their analytic potential is unfulfilled. Also, it is doubtful that the process of constructing an activity web can be made rigorous and repeatable.